Dear Dollar Stretcher,
They say rent should be a third of your salary, or something like
that. How much should be allocated to credit card debt if you made
the mistake of getting into debt? If I paid each credit card a
little bit, I'd still owe about $400 a month. What should my income
be to pay that much each month but still not be in trouble? For
instance, if I only earned $1,200 a month, I couldn't be expected to
pay rent, food, etc., AND credit cards. But if I was making $100,000
a year, $400 a month wouldn't seem like much. Is there a way to calculate this?
Linda

Approximately 1 in 3 of us have at least one credit card with a
balance due. And with a new law that required higher minimums taking
effect in 2006, more and more consumers are wrestling with their
minimum payment.

So Linda asks a good question. How much debt repayment can I fit into
my budget? And, yes, she's right. Someone with a $100,000 annual
income can afford more than the person who takes home $1,200 each
month. So let's see if we can't come up with some guidelines for Linda.

Most family budgets are dominated by three categories: housing, auto
and food. Combined they typically take up 65 to 70% of the budget.
That leaves 30 to 35% for everything else: insurance, clothing,
medical, dental, entertainment & vacations, education, property
taxes, savings, and debt repayment.

Most of these categories will require between 3 and 7%. Which will
quickly consume the remaining portion of your income. Each family is
a little different but most families can commit about 5% of their
paycheck to repaying debt without twisting their budget out of shape.

How does that work out in Linda's case? A monthly payment of $400 is
5% of $8,000. So Linda would need to be bringing home $8,000 after
taxes to hold to this budget. I hope that she is making $96,000 a
year. But, there's a good chance that she's not. So she might need to
make some adjustments.

Even if she is making that much money, it's still wise to pay down
her credit card balance. That's because it is unlikely to stay at the
current level. The reason is simple. Life happens.

There will always be 'unexpected' home and auto repair bills. Even
with good medical insurance the deductible on a broken arm can be
significant. And taking a nice vacation is real tempting.

If Linda is struggling already she probably doesn't have money saved
for these 'emergencies'. So they'll go on her credit card. And, that
will boost her balance. The new minimum will only go up a little bit.
But the hill she's climbing just got a little steeper.

The sad part is that many people fall into credit card debt because
they can't afford to completely pay for whatever they bought during
the month. Trouble is the interest that they'll owe only makes the
original purchase more expensive. So they'll pay even more for
something that they couldn't afford in the first place.

So what can Linda do? Take aggressive steps to pay down her credit
card balance. Beginning now.

The biggest opportunities are where she spends the most - housing,
auto and food. It may be time to move to a smaller home or apartment,
or take in a roommate. Replace an expensive car with a cheaper one.
Commit to eating at home until her debt is paid off.

Linda should also look for ways to make small contributions to her
'debt repayment fund'. It's time to consider dropping premium cable
channels, mocha lattes and other non-essentials. You'd be surprised
how quickly these items can add up to a sizeable amount. Not only
will she be reducing debt, she'll feel better about taking steps to
reach her goal.

Some of these may seem overly drastic. But they are meant to be
drastic. Linda is heading for a financial wreck.

Here's how it will unfold. 'Unexpected' expenses will add to her
balance and her monthly minimum. If her minimum payments begin to
exceed 5% of her budget, she'll soon find herself unable to make the
monthly payment.

Then things will snowball. Each month she'll struggle to make all the
minimum payments on time. One day a payment will be a little late.
Her interest rates will go up. On all of her cards. That'll increase
her minimum payment. That, in turn, will make it almost impossible to
cover the new minimums. Her credit rating will go down. She'll
trigger a chain of events that will take up to ten years to correct.

Linda is wise to correct it now while she still has time. Some of the
steps she'll need to take will be painful. But she'll be avoiding
much more financial pain in the future.

Gary Foreman is a former financial planner who currently edits
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